There have been many attacks claiming that LINE's cash flow will be diminished or is not supportive of current dividend levels. This is refuted by history and the accounting proven, but I know many holders and potential buyers simply don't understand or trust accountants. For these I think this personal account will shed some light and ease concerns. I found it as a reply in one of the seeking alpha articles.
Great article but you missed something which shows that Linn is in much better shape than the shorts and negative magazine articles imply.
You pointed out that the 2012 expenses of depletion, depreciation and amortization amount to $606 million. This expense is a non-cash expense which I would like to explain since I have been intimately involved in oil and gas investments.
My family has a 1-2% interest in 22 wells drilled with Anadarko and Noble Energy. The wells have been drilled on land we leased with others over 50 years ago much like Chesapeake Energy and other giants in the North American energy industry lease land.
We write off these wells: amortization, depreciation and depletion over 1-10 years. So the cost of all wells is expensed over 10 years. Our wells usually produce over a 50 year time period. Yes the greatest production takes place during the first 5 years of the wells life, that is our history. But what investors in oil and gas need to know is that most wells drilled in North America produce for 25-50 years before they are capped and production stops. Many wells in California have been producing for 75 years or more. I went to Beverly Hills High School in the 1960's and those 28 wells which were producing at that time from the wells drilled on the high school grounds are still producing today.
what kind of interest do you have? is it RI or WI? you probably have RI, that is the reason you only have small chagre (transportation fee deduction), RI do not have to pay any other cost buy transportation cost. As company spend more money on CAPX cost, it is added to depreciation base. Depreciation never goes away (in 99% of the time) GAAP is taken on historical CAP cost, IFRS is take on market adjustable base.
Linn Energy is writing off $606 million dollars of costs related to drilling wells in 2012 but those wells will produce for another 50 years. Those deductions are front loaded as the wells will produce income for half a century. Our expenses for our 1-2% interest in our 22 wells is about $1,000 per month, not much. Investors need to realize that expensing the cost of the wells through depreciation, amortization and depletion in 1-10 years leaves the next 40 years of production free of most expenses.
More importantly our 22 well sample produces as much income today as it did 50 years ago after 50 years of drilling. Yes after 90% decline in production we are still making as much money now as 50 years ago. Why is that? It is inflation in the price of commodities. Look at the cost of most commodities: food, energy, gold, silver, beef, etc., 50 years ago, then 45 years ago, then 40 years ago, then 35 years ago, etc. These are increasing all the time because the costs to produce, land costs, equipment cost and all commodity prices are increasing.
The gas and oil Linn Energy has purchased is going to go up significantly over the next 40-50 years that these wells produce. GAAP accounting and SEC accounting does not allow you to take your assets and calculate values based upon inflation and what these wells are going to be worth every 5 years forward and it is significant. To the contrary, they (SEC, GAAP-accountants) make you discount the wells and production by a Present Value (PV) factor calculation and they require that you reflect losses based upon current market declines in the values of commodities and hedges you own. In reality, all of these accounting games are to be conservative with the accounting statements when in the real world commodities and real estate (oil and gas) goes up in cost all the time as more people use more each decade and drive up prices or the printing of money by governments drives up costs to reflect the declining value of printed paper (currency).
This is why my family makes more income today on our interest in 22 wells than we did 45-50 years ago when most of them were drilled.
Linn's position is actually much stronger than the financial statements show. Why? Because their oil and gas is going to be worth much more in 5 years, 10 years, etc.
The Russia Ministry of Energy is predicting that the U.S. will supply 10% or more of the natural gas in the world that will be sold to consuming nations in 5 years (2017-2018). We have to assume that the Russians study this area quite closely as they are the number 1 or number 2 seller of natural gas in the world to other nations and they understand their competition and where it coming from.
In 5 years the U.S. will be exporting significant quantities of energy at world prices. Today, natural gas sells for around $4mcf in the U.S. but sells for $10-14mcf internationally.
What I am implying is that the increase in energy prices that have impacted the price my family has received on its 22 oil and gas wells for the last 50 years is not going to change it is not going away. In fact there is less oil, less productive wells and more people consuming it today than 50 years ago when wells drilled in Mexico and the Middle East gushed at 10 times greater levels than the wells produced today.
Remember, China had no cars 50 years ago. Today, China has 10-15 million more cars, buses and trucks on the road than each previous 12 month period.
They are going to use energy to run them and while China burns a great deal of coal for energy, car engines do not burn coal. If they did, the pollution situation would be catastrophic.
I am long Linn Energy, Breitburn Energy and Chesapeake Energy.